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Diseconomies of scale

Economic theory predicts that a firm
may become less efficient if
it becomes too large. The additional costs of becoming too large are
called diseconomies of scale.

Diseconomies of scale result in rising long run average costs which
are experienced when a firm expands beyond its optimum scale, at Q.

Examples of diseconomies include:

Larger firms often suffer poor
communication because they find it difficult to maintain an
effective flow of information between departments, divisions or
between head office and subsidiaries. Time lags in the flow
of information can also create problems in terms of the speed of
response to changing market conditions. For example, a large
supermarket chain may be less responsive to changing tastes and
fashions than a much smaller, ‘local’ retailer.

Co-ordination problems also affect large
firms with many departments and divisions, and may find it much
harder to co-ordinate its operations than a smaller firm. For
example, a small manufacturer can more easily co-ordinate the
activities of its small number of staff than a large manufacturer
employing tens of thousands.

‘X’ inefficiency is the loss of management
efficiency that occurs when firms become large and operate in
uncompetitive markets. Such loses of efficiency include over paying
for resources, such as paying managers salaries higher than needed
to secure their services, and excessive waste of resources. ‘X’ inefficiency means that average costs are higher than
would be experienced by firms in more competitive markets.

Low motivation of workers in large firms
is a potential diseconomy of scale that results in lower
productivity, as measured by output per worker.

Large firms may experience inefficiencies
related to the
principal-agent problem. This problem is caused because the size
and complexity of most large firms means that their owners often
have to delegate decision making to appointed managers, which can
lead to inefficiencies. For example, the owners of a large chain of clothes
retailers will have to employ managers for each store, and delegate
some of the jobs to managers but they may not necessarily make
decisions in the best interest of the owners. For example, a store
manager may employ the most attractive sales assistant rather than
the most productive one.